EU Sustainable Finance Disclosure Regulation—An Update – Fund Management/ REITs

Key takeaways:

• The European Advisory Authorities (“ESAs”) have
  issued final Regulatory Technical Standards (“RTS”) for
  sustainability related disclosures under the Sustainable Finance
  Disclosure Regulation (“SFDR”), as well as questions to
  the Commission regarding the interpretation of the SFDR and EU
  Taxonomy for sustainable activities.




• However, further changes to the RTS may still take place as in
  May the Commission published two letters to the ESAs, calling for
  changes to the environmental conditions and Principal Adverse
  Impact (“PAI”) indicators in the RTS.




• Various delegated Directives and Regulations to the Alternative
  Investment Fund Managers Directive (“AIFMD”),
  Undertakings Collective Investment in Transferable Securities
  (“UCITS “)”, and the Markets in Financial
  Instruments Directive (“MiFID”) arising from SFDR will
  first apply in August 2022.

The EU Regulation on sustainability-related disclosures in the
financial services sector (the “SFDR“) came into effect in March 2021.
Subsequently, the European Supervisory Authorities (the
“ESAs”) produced on 6 April 2022 the final Regulatory
Technical Standards (“RTS“), including the templates for
disclosure by funds within Article 8 or Article 9 of SFDR. The RTS
are subject to final approval by the European Parliament and
Council. Since that date, the Commission and the European
Supervisory Authorities have published documents which indicate
that SFDR rule-making has not yet finished its initial phase.

The ESAs published on 13 May 2022 a set of questions that they have recently
asked the European Commission (the “Commission”) in
relation to interpretation of the SFDR and EU Taxonomy for
sustainable activities. This is an important document: the ESAs
have raised some key questions of interpretation that the industry
as a whole has debated since the inception of SFDR, so the
Commission’s answers will be crucial.

The questions include the following:

• Whether a firm can consider principal adverse impact
  (“PAI”) factors for only a sub-set of its funds and
  disclose that approach under Article 4 of SFDR, which covers a
  firm’s website disclosure on its consideration of PAI
  factors.




• The application of SFDR to a financial adviser, in particular
  where the adviser recommends investments that are not financial
  products in scope of SFDR, such as investments in securities and
  bonds.




• Whether Articles 6 and 7 of SFDR (that require firms to include
  sustainability-related information in all their financial products)
  apply to financial products that are no longer available to
  investors.




• If a fund in scope of Article 8 or 9 of SFDR does not invest in
  companies with good governance, whether it is able to continue to
  classify itself under Article 8 or 9 of SFDR.




• If a fund in scope of Article 8 does not commit to invest in
  environmentally sustainable investments, whether such fund is
  obliged to disclose information on Taxonomy alignment and, if it
  then invests in environmentally sustainable investments, whether
  the fund is obliged to disclose information on Taxonomy
  alignment.

Separately, in relation to the RTS containing the disclosure and
reporting templates, the Commission published two letters to the
ESAs on 6 May 2022, each proposing amendments to the RTS. The first letter invites the ESAs to make specific
changes to the RTS in light of the recently adopted Complementary
Climate Delegated Regulation. The Complementary Climate Delegated
Regulation sets out the specific conditions under which fossil gas-
and nuclear energy-related activities are considered activities
that contribute to climate change transition and hence qualify
under the EU environmental Taxonomy. Hence, the Commission requires
specific disclosure in pre-contractual documents and ongoing
reporting of a fund’s exposure to investments in fossil gas-
and nuclear energy-related activities. We can expect changes to the
RTS (and templates) in due course.

The second letter invites the ESAs to consider
much broader changes to the RTS. The RTS include the list of PAI
environmental and social indicators which firms within scope of
Article 4 of the SFDR are required to measure and report. In
open-ended language, the letter invites the ESAs to review the PAI
regime by considering extending the list of PAI factors and
refining the content of the factors by revising their definitions,
methodologies, metrics and presentation. The letter suggests that
more information be given in relation to “evidence that
investments align with the standards” and that
“implementation and application efforts” in relation to
PAI factors take place. The breadth of the review is fairly
unclear, but in principle could involve a wholesale review of the
PAI regime. Separately, the Commission invites the ESAs to propose
amendments to the Regulatory Technical Standards on information
given in pre-contractual disclosure and periodic reporting on
decarbonisation targets, including “intermediary targets and
milestones”. There is also a reference to a possible review of
the information given in pre-contractual disclosure and periodic
reporting on alignment of the portfolio to the EU environmental
Taxonomy.

Lastly, various delegated Directives and Regulations to the
Alternative Investment Fund Managers Directive (“AIFMD”),
Undertakings Collective Investment in Transferable Securities
(“UCITS”) and the Markets in Financial Instruments
Directive (“MiFID”) arising from SFDR first apply in
August 2022.

A new MiFID Delegated Regulation on integration of
sustainability factors and preferences into firms’
organisational requirements and operating conditions requires a
client’s sustainability preferences to be taken into account in
the suitability check. This will apply where a firm regulated under
MiFID provides investment advice or portfolio management to a
client. Sustainability preferences means the client’s
preference to invest in financial instruments with a minimum
proportion of environmentally sustainable investments
(Taxonomy-aligned investments), with a minimum proportion of
sustainable investments (the general concept under Article 2(17) of
SFDR) or that take into account principal adverse impacts
“where qualitative or quantitative elements demonstrating that
consideration are determined by the client or potential
client”. As noted above, there is present uncertainty as to
whether financial advisers are in scope of SFDR in relation to
investments (such as bonds) that are not themselves in scope of
SFDR. The Delegated Regulation also requires firms to take into
account sustainability risks in overall organisational
requirements, in risk management policies and in conflicts of
interest (where a conflict may affect the sustainability
preferences of a client). This applies from 2 August 2022. The
European Securities and Markets Authority (“ESMA”)
recently published a consultation on guidelines on the suitability
check, including draft guidance on how firms should include
sustainability factors in the suitability check.

For Alternative Investment Fund Managers (“AIFMs”), a
Delegated Regulation on sustainability risks and factors to be
taken into account by AIFMs requires AIFMs to take into account
sustainability risks (and principal adverse impacts, if they
consider them) in the due diligence process and sustainability
risks in the risk management policy and to update conflicts of
interest policies for conflicts that may arise from the integration
of sustainability risks. It also requires firms to take into
account sustainability risks in overall organisational
requirements, including responsibilities of the governing body.
This applies from 1 August 2022.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.